Cost management Techniques



Cost management techniques - Traditional manufacturing philosophy focuses on the need to continue to use valuable resources (such as manufacturing equipment)
Cost Management Techniques

Traditional vs modern manufacturing philosophy

Traditional manufacturing philosophy

Traditional manufacturing philosophy focuses on the need to continue to use valuable resources (such as manufacturing equipment) to their full capacity and to maximise the length of production runs.  The main features of the traditional approach to manufacturing are as follows:

  1. Labour and manufacturing equipment are so valuable they should not be left idle.
  2. Resulting inventory not needed should be stored (thus hiding inefficient and uneven production methods).
  3. To increase efficiency and reduce production cost per unit, batch sizes and production runs should be as large as possible.
  4. Concerned with balancing production run costs and inventory holding costs.


Modern manufacturing philosophy

The main features of the modern approach to manufacturing are as follows:

  1. Smooth, steady production flow (throughput)
  2. Flexibility, providing the customer with exactly what is wanted, exactly when it is wanted (making the organisation a more complex affair to manage), so as to achieve competitive advantage
  3. Volume versus variety – greater variety in volumes required by customers.
  4. Just-in-time – that is, little or no inventory.


Total Quality Management (TQM)

TQM is the general name given to programmes which seek to ensure that goods are produced and services supplied of the highest quality.

Quality management becomes total (total quality management (TQM)) when it is applied to everything a business does.

The management of quality is the process of:

  1. Establishing standards of quality for a product or service
  2. Establishing procedures or production methods that ought to ensure that these required standards of quality are met in a suitably high proportion of cases
  3. Monitoring actual quality
  4. Taking control action when actual quality falls below standard

There are two basic principles of TQM:

  1. Get it right, first time: TQM considers that the costs of prevention are less than the costs of correction. One of the main aims of TQM is to achieve zero rejects and 100% quality.
  2. Continuous improvement: A second basic principle of TQM is dissatisfaction with the status quo: the belief that it is always possible to improve and so the aim should be to ‘get it more right next time’.


Costs of quality

Failing to satisfy customers’ needs and expectations, or failing to do so right first time, has a cost.


The COST OF QUALITY is ‘the difference between the actual cost of producing, selling and supporting products or services and the equivalent costs if there were no failures during production or usage’.

The cost of quality can be analysed into the following:

  1. COST OF PREVENTION – ‘the costs incurred prior to or during production in order to prevent substandard or defective products or services from being produced’ for example Quality engineering and Training in quality control.
  2. COST OF APPRAISAL – ‘costs incurred in order to ensure that outputs produced meet required quality standards’ for example Acceptance testing and Inspection of goods inwards.
  3. COST OF INTERNAL FAILURE – ‘the costs arising from inadequate quality which are identified before the transfer of ownership from supplier to purchaser’ for example Failure analysis and Losses from failure of purchased items
  4. COST OF EXTERNAL FAILURE – ‘the cost arising from inadequate quality discovered after the transfer of ownership from supplier to purchaser’ for example Administration of customer complaints section and Cost of repairing products returned from customers.

External failure costs are the costs of failing to deliver a quality product externally. The sum of internal failure costs, prevention and appraisal costs is the cost of failing to deliver a quality product externally.

Management accounting reports

Management accounting systems can help organisations achieve their quality goals by providing a variety of reports and measures that motivate and evaluate managerial efforts to improve quality – including financial and non-financial measures.

Traditionally, the management accounting systems focused on output, not quality.


Kaizen Costing

Kaizen costing aims to reduce current costs by using such tools as value analysis and functional analysis.

KAIZEN COSTING focuses on obtaining small incremental cost reductions during the production stage of the product life cycle. It is based on the idea of an ongoing process of reviewing how the business operates in order to identify and implement cost savings. Each individual action may result in a small cost saving, but these are incremental and can add up to a material saving.

The cultural requirements of Kaizen costing are that the whole workforce should be involved, as suggestions for improvements can come from anyone.

The previous year’s actual production cost serves as the cost base for the current year’s production cost. A reduction rate and reduction amount are set (Kaizen cost goals). Actual performance is compared to the Kaizen goals throughout the year and variances are monitored. At the end of the current year, the current actual cost becomes the cost base for the next year. New (lower) Kaizen goals are set and the whole process starts again.


How are Kaizen goals met?

  1. Reduction of non-value-added activities and costs
  2. Elimination of waste
  3. Improvements in production cycle time


Just-in-time (JIT)

JIT is a pull-based system of production, pulling work through the system in response to customer demand. This means that goods are only produced when they are needed, eliminating large stocks of materials and finished goods. In particular, JIT seeks to achieve the following goals:

  1. elimination of non­value added activities;
  2. zero inventory;
  3. zero defects;
  4. batch sizes of one;
  5. zero breakdowns;
  6. a 100% on-time delivery service.

Key characteristics for successfully operating such a system are:

  1. High quality: possibly through deploying TQM systems.
  2. Speed: rapid throughput to meet customers’ needs.
  3. Reliability: computer-aided manufacturing technology will assist.
  4. Flexibility: small batch sizes and automated techniques are used.
  5. Low costs: through all of the above.

Key features of companies operating in a JIT and TQM environment are:

  1. high level of automation
  2. high levels of overheads and low levels of direct labour costs
  3. customised products produced in small batches
  4. low stocks
  5. emphasis on high quality and continuous improvement.


Business process re-engineering (BPR)

BPR is all about major changes to how business processes operate.

Business process re-engineering looks at how processes can be redesigned to improve efficiency.

Business process re- engineering involves examining business processes and radically redesigning these processes to achieve cost reduction, improved quality and customer satisfaction.

A re-engineered process has certain characteristics:

  1. Often several jobs are combined into one.
  2. Workers often make decisions.
  3. The steps in the process are performed in a logical order.
  4. Work is performed where it makes most sense.
  5. Checks and controls may be reduced, and quality ‘built-in’.
  6. One manager provides a single point of contact.
  7. The advantages of centralised and decentralised operations are combined.

The main stages of BPR:

  1. Process identification: Each process is recorded and analysed to find out whether it is Necessary, Adding value, Supporting another value adding process.
  2. Process rationalization: Those processes which are not adding value, or which are not essential to supporting a value-adding process are discarded.
  3. Process redesign: The remaining processes are redesigned, so that they work in the most efficient way possible. At this stage detailed operating procedures need to be produced for all processes that are to be performed manually.
  4. Process reassembly: The re-engineered processes are implemented, resulting in tasks, department and an organisation that works in the most efficient manner.

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